German bond yield highest in a year as Draghi opens door to policy tweak

By Dhara Ranasinghe

LONDON (Reuters) - Germany's short-dated bond yields jumped to their highest in a year, and the euro hit a nine-day peak on Tuesday, after ECB chief Mario Draghi opened the door to tweaks in the bank's ultra-easy monetary policy as the economy recovers.

Speaking at a European Central Bank conference in Sintra, Portugal, Draghi said deflationary forces had been replaced by inflationary ones.

But any change in the bank's stance, which includes sub-zero rates and massive bond purchases, should be gradual as "considerable" monetary support is still needed and the rebound in inflation will also depend on favourable global financing conditions.

For investors, the remarks were a departure from the cautious tone adopted at a post-meeting news conference earlier this month, sparking a sell-off across euro zone bonds.

"My reading is that on the policy front there hasn't been a whole lot of change but if you compare it to the comments after the ECB meeting, they were on the hawkish side," said Antoine Bouvet, a rates strategist at Mizuho. "He was quite optimistic that wages will pick up."

The yield on Germany's two-year Schatz bond, also facing pressure from new bond supply on Tuesday, rose to minus 0.56 percent, its highest in a year.

German long-dated bond yields soared 7 basis points to a four-week high at 0.32 percent and were on track for their biggest one-day jump since early May.

Across the single currency bloc, euro zone bond yields were 6-9 bps higher on the day.

The euro also rallied after Draghi's comments, hitting a nine-day high at of $1.1291, up 0.9 percent on the day.

"He (Draghi) has been speaking more about the medium term and the ECB being a bit more sure that inflation will return to target," said Cathal Kennedy, European economist at RBC in London.

"But I don't think the message is significantly different to what we have heard before. There seems to be a bit of market overreaction."

Draghi was the first of a slew of central bankers slated to speak on Tuesday.

In Britain, the Bank of England Governor Mark Carney spoke at a news conference following the release of the financial stability report.

Janet Yellen, the head of the U.S. Federal Reserve, speaks in London later in the day. Other Fed officials are also on the calendar.

Elsewhere, Germany sold 3.172 billion euros worth of two-year government paper.

(Additional reporting by John Geddie, editing by Pritha Sarkar)